4Market Cap of Stock Market > GDPWarren Buffett:The percentage of total market cap relative to the US GDP is “probably the best single measure of where valuations stand at any given moment.”US GDP is $16.8 trillion and total market cap of U.S. stocks is $19.8 trillionSince 1970, only three times that market cap has equaled GDP:(148%) – Nasdaq lost 78%2007 (111%) – S&P 500 lost 56%2014 (118%) -- ????Economics Ph.D. John Hussman: “ since the 1940’s, the ratio of equity market value to GDP has demonstrated a 90% correlation with subsequent 10-year total returns on the S&P 500. Present level is associated with projected annual total returns on the S&P 500 of just over 1.8% annually.”

5Other Warning SignsHigh-flying momentum stocks in the Internet (e.g., GOOG, FB, PCLN, NFLX) and biotechnology (e.g., ALXN, REGN, CELG, GILD) sectors have already begun to crack with steep corrections.Nasdaq/NSYE relative strength dropped decisively below its 10-week moving average for the first time since late September 2012.University of Michigan finance professor Nejat Seyhun: insider selling is “as pessimistic as I’ve ever seen over the last 25 years.” More pessimistic than in 2007 (before 37% bear market in 2008) and more pessimistic than in 2011 (before 20% market correction).The Investor Intelligence bull/bear ratio has been above 3 for most of the past five months, which is longer than any time since the 1980s.But the S&P 500 remains comfortably above its uptrending 10-month moving average, so the Ivy Portfolio market-timing system continues to flash a “fully invested” signal.

8OFI’s 10-Year Stock Seasonality Navigator“Seasonality” refers to particular time frames during the calendar year when a company’s stock price is influenced by recurring forces that produce a consistent price direction – either bullish or bearish. Some stocks tend to go up consistently at certain times in the year.For example, consumer-related stocks (e.g., food, drugs, beer, leisure, utilities, media, and retail) outperform the overall market between May 1st and October 31st and manufacturing and production stocks (e.g., consumer durables, chemicals, construction, mining, steel) outperform between November 1st and April 30th.Seasonal tendencies can be based on weather events (temperature, precipitation, planting cycle), spending surges (holiday and back-to-school shopping, end of government fiscal years, tax refunds), new-product announcements at industry conferences, or financial events (quarterly earnings reports, dividend hikes, and regulatory approvals.).

17Generates Income With Less Risk than Owning StockPut Credit SpreadsGenerates Income With Less Risk than Owning StockPut Sellers: Obligation to buy stock at a strike priceSelling OptionsReceive fixed amount of instant cashRisk limited to width of put strikes.Stock Price Does not Need to RiseMaximum profit occurs if the stock does not rise or even falls a little bit.

20Short Put Options Can Be Exercised EarlyPut Credit SpreadsShort Put Options Can Be Exercised EarlyAlthough early exercise is rare, it does happenUsually able to buy back put and sell longer-dated put if not ready to buy the stock (i.e., Vertical Roll)Buying stock at a discount from the current market price is a good thing! Can easily sell assigned stock and re-initiate new put spread.No margin call for involuntary early assignment because brokers know that your risk is limited to width of put spread. “Same-day substitution” rule.

21Proper Use of Options LeveragePut Credit SpreadsProper Use of Options LeverageTwo Ways to Use Option Leverage – One Bad, One GoodBad: Buy more stock for same amount of cash100 shares of Reynolds American for $5,650Since one RAI Aug. $55/50 put spread can be sold for $1.35 per share and risk of $365 per contract, one could sell 15 put spreads for similar $5,475 of risk (15 times share exposure)Good: Buy same stock for less cashSell one RAI put spread for $365 of risk (93.5 Percent Less Risk than 100-share purchase of $5,650)15 different put-spreads for same price as one stock position! Using options optimizes portfolio diversification.

22Portfolio ConstructionPut Credit SpreadsPortfolio Construction$135,000 Equity Portfolio. Reasonable diversification requires 20 holdings of $6,750 each. Expected portfolio return = 10%, or $13,500.50 separate positions of two-contract put credit spreads at per-contract income of $135 and per-contract cost of $365 would yield same $13,500 income, but the total investment risk would be only $36,500 (50*2*$365), leaving $98,500 in cash.Maximum dollar loss of put-spread positions is $36,500 or 27.0% of portfolio. Much better than 100% potential loss on stocks. But chance of suffering maximum loss on all 50 put-spread positions is infinitesimal, whereas chance of losing 27% on stock portfolio is definitely possible.Probability of making $13,500 income with put spreads is much higher than buy-and-hold stocks because put spreads do not require stocks to rise.

26Autozone (NYSE: AZO) May 2nd–to-June SeasonalityFrequency of up or down is not important for neutral iron-condor trades.Magnitude of yearly moves is what counts.Only one year out of 10 had a price move in double-digits (12.1% in 2005).All the nine other years saw price moves of 7.2% or less in magnitude.Conclusion: Choose short strikes 8% out-of-the-money both up and down from current stock price.

29Iron Condor Pros and Cons Pros: Cons:Double credit and yet single margin requirementCan’t lose on both credit spreads; guaranteed to win on at least one of themJune $480/$470put spread has $0.80 credit and $920 margin requirement; June $570/$580 call spread has $1.00 credit and $900 margin requirementIf trades done separately, two margin requirements totaling $1,820, but iron condor margin requirement only $920.Cons:Need to worry about two short option strikes, not just one. Vulnerable to strong move in either bullish or bearish direction. (2 bad scenarios, 1 good scenario).Four option legs, so commission cost is heavy both initial and if roll.